Download Institutionalist-Post Keynesian Macroeconomics or Evolutionary

Institutionalist-Post Keynesian Macroeconomics or “Evolutionary Keynesianism”
Chris Niggle
University of Redlands
[email protected]
Prepared for the AFEE/ASSA session “Empirical and Theoretical Developments in
Institutionalist and Post Keynesian Macrodynamics,” Boston, Mass., January 2006.
Revised January 18, 2006
The dominant paradigm in mainstream macroeconomics is a synthesis of New
Keynesian and New Endogenous Growth economics, which has modified the New
Classical and monetarist-based neoliberal macroeconomics known as the “Washington
Consensus.” The same model appears dominant in the UK, and perhaps in Euroland’s
European Central Bank and the EU countries as well. Evolutionary/Institutionalist and
Post Keynesian economics (IPK) offers a very different approach to policy making which
could be characterized as “evolutionary Keynesianism.”1 This paper compares and
contrasts the two approaches to macroeconomics.2
Dominant (or hegemonic) in the mainstream means:
1.
The view of most policy advisors (Federal Reserve, Council of Economic
Advisors, IMF, World Bank, Bank of England, European Central Bank).
2.
Appears in the most widely adopted textbooks and taught in the universities.
3.
Taught and supported in the elite graduate schools.
4.
Accepted by the majority of the profession.
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The history of macroeconomics over last 50 years can be interpreted as a
dialectical struggle between two opposing visions of the economy (as in Schumpeter’s
“pre-analytic visions” with which economists begin their work):
1.
Stable, tending toward short run equilibrium at the natural rate of unemployment
and potential output; tending toward a “steady state” long run rate of growth determined
by the rate of technological change and growth in inputs. Business cycles are caused by
external disturbances or supply shocks. The role of the state should be limited to
providing the necessary institutional infrastructure, especially property rights, money and
competitive markets. This approach originated in classical economics and reappeared in
New Classical Economics (NCE); it also underlies Solovian growth theory (see Chs. 5
and 11 in Snowden and Vane 2005 for good overviews of NCE and Solow’s growth
model).
2.
Inherently unstable, with unemployment usually greater than optimal, and
capacity utilization lower than optimal. The actual growth rate is determined by short run
cycles in production as well as the factors cited in classical, NCE and Solovian growth
theory; the growth rate is usually lower than optimal. Demand is unstable and usually
insufficient. Macro policy can improve performance greatly. Marx, Keynes and
Institutionalist-Post Keynesian economists share this view of the economy.
3.
New Keynesian economics (NKE) emerged in the 1980s; it occupies a 3rd,
intermediate position.
2
New Keynesian Economics
NKE accepts most of the NCE microeconomic core: flexible wages, prices and
interest rates lead the economy to the “natural rate” of unemployment (usually termed the
NAIRU or “non-accelerating rate of inflation unemployment rate”), which can be
described as a Walrasian and Hicksian general equilibrium. But the adjustment process
may take a long time due to “coordination failures” caused by inflexible wages and
prices. The level of GDP fluctuates around the “potential” GDP which is produced when
unemployment is at the natural rate. Business cycles are temporary deviations from the
long run trend growth rate, caused by supply or demand shocks. The trend growth rate
and the natural rate of unemployment are both “strong attractors” dominated by the rate
of technological change and the institutional and historical factors which influence labor
markets.
Large demand gaps can and should be offset by demand management policies,
using monetary policy. Fiscal policy is too clumsy a tool because the political and
implementation time lags are too long, and the multiplier effects of fiscal policy are
small. Therefore, fiscal policy is only useful for extreme crises and monetary policy
should be used for normal stabilization situations; although “fine tuning” is impossible,
“rough tuning” is possible. This represents a modification of the extreme laissezfaire/nonintervention approach supported by NCE.
NKE recognizes the social costs of recessions and the importance of demand
factors; it defends countercyclical monetary policy and advocates demand management
using “constrained rules” such as (John) Taylor’s rule. In most versions, the procedure is
to estimate (or forecast) potential GDP and any demand gap, then adjust (nominal and
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real) interest rates to move actual GDP to its potential; target interest rates rather than the
money stock, since the velocity of money is unstable and the money supply is
endogenous. Fiscal budgets should be balanced over the business cycle. (See Mankiw
1990 and Mankiw and Romer 1991 for descriptions of the NK approach.)
The principal contribution of NKE has been to provide microeconomic
foundations that explain why wages and prices are sticky in modern economies
(imperfect competition, management strategy, menu costs, information costs, contracts,
efficiency wages are often cited) and to model the implications of this market behavior
for macroeconomics. NKE rationalizes state intervention to improve short period
macroeconomic performance. Reducing the natural rate of unemployment requires
restructuring labor markets (increasing labor market “flexibility”).
New Endogenous Growth Theory
Most NKE economists also accept New Endogenous Growth theory (NEG),
which first appeared in the late 1970s, early 1980s (Romer 1994 provides an account of
the rise of NEG; see also Chapter 11, Snowden and Vane 2005). NEG accepts the
NCE/NKE vision of the natural rate of unemployment and the Solow growth model
equilibrium steady state growth rate (the latter determined primarily by technological
change) as the normal states which the economy tends toward. NEG also accepts the
NCE/Solow argument that savings finances investment, so that an increase in the savings
rate leads to more investment and at least temporarily a higher growth rate. But NEG
rejects the NCE/Solow proposition that diminishing marginal returns to capital occurs as
the capital/labor (K/L) ratio increases. Increasing returns are possible, so that the growth
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rate does not necessarily tend toward Solow’s rate of technological change, the “steady
state” growth rate for per capita real income.
Increasing or constant returns to capital are seen as possible due to phenomena
such as:
1.
Effects of R&D, spillover effects, externalities, learning by doing, and the
interrelationships between investment in fixed and human capital.
2.
Economies of scale and scope across industries, technologies and economies.
NEG implies that:
1.
Higher saving and investment rates can lead to permanently higher growth rates.
2.
Conditional convergence of growth rates for countries with similar savings rates
may not occur.
3.
Poor countries will not automatically catch up to rich countries, even if they save
a lot.
4.
There exists a wide range of intelligent policy choices to promote growth,
including public investment in fixed capital, human capital, research and other forms of
public infrastructure. Policy promoting high private investment (and saving) rates are
growth promoting. Both NK and NEG support state intervention to promote the wealth
of nations (full employment and higher growth rates); again, this is quite different from
the “free market fundamentalism” and radical laissez-faire of New Classical Economics.
Institutionalist and Post Keynesian Economics: Evolutionary Keynesianism
Institutionalist and PK economists tell similar macro stories. The
macroeconomics of first and second generation evolutionary or Institutionalist
economists such as Commons, Veblen, and Mitchell were similar to Keynes’s in many
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respects. Many of the recent contributors to Institutionalist macroeconomics published in
the JEI, such as John Cornwall, Paul Davidson, Hyman Minsky, Basil Moore, and Randy
Wray also contributed to Post Keynesian economics. 3
Institutionalist and Post Keynesian economists argue that economic development
is conditioned by and transforms economic institutions such as money, markets and
property rights: transformational growth leads to structural and institutional change (Nell
1992). Economies should be understood as complex systems with emerging properties
that successively develop different laws of motion and pose different problems (Moore
1999). State intervention to create or change institutions is often necessary to promote
the goals of full employment, economic growth, equity, social justice and harmony.
Given the emphases on institutional change, full employment and demand management,
“evolutionary Keynesianism or evolutionary macroeconomics” are appropriate terms for
the IPK approach and models.
There are some similarities between IPK and NKE (the importance of aggregate
demand is the chief common element) and IPK is consistent with much of NEG, there are
however important distinctions between IPK and the orthodox consensus with respect to
ultimate goals, assumptions, method, analysis and policy.
Differences between IPK and NK/NEG
1.
IPK – especially PK – emphasizes the importance of “fundamental” or “absolute
uncertainty,” Paul Davidson’s “non-ergodicity,” as a characteristic of the real world
which has important implications for both theory and policy (Davidson 2005). NCE and
NKE economics both assume “probabilistic risk,” which is more tractable but unrealistic.
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2.
The economy is inherently unstable because of this profound uncertainty-which
implies great risk for many crucial decisions- and the resultant instability of expectations
regarding profits from investment and the future price of assets. Financial instability and
economic instability are dialectically interactive and must be constrained with appropriate
institutions. Instability is not as important a concern in NKE economics, and financial
markets are discussed largely as an afterthought. Financial markets and money are
central to IPK macro (following Keynes’s attempt to develop a “monetary theory of
production.” (See Davidson 2005, Niggle 2004, Rotheim 1998 and Setterfield 2002 for
introductions to PK economics and contrasts between IPK and NKE/NEG.)
3.
Economies are best understood as “complex systems” which are “self organizing”
and exhibit “emerging properties” as they develop - using the insights and language of
complexity analysis (Moore 1999). This proposition is a modern version of a core
concept in original evolutionary economics: since institutions and economies evolve
through historical time, theory must be institutionally specific if it is to be useful. Since
the behavior of a complex system is not simply the outcome of the behavior of its
components, the complexity proposition also means that we can’t adequately understand
an economy (a complex system) by observing the behavior of a component and
extrapolating that behavior to the system as a whole (as Keynes observed in his “paradox
of thrift” argument). Rather than the “microeconomic foundations of macroeconomics”
(as in NCE and NKE) we need to understand the “macroeconomic foundations of
microeconomics.”
4.
External shocks and inflexible wages and prices explain recessions and deviations
from trend for NKE; IPK argues that even if wages and prices were flexible, full
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employment is not guaranteed. There is no unique natural rate or NAIRU which the
economy gravitates toward and which acts as a strong attractor. IPK argues that flexible
wages and prices would enhance instability since falling wages and prices in a recession
would probably reduce profits, investment and employment. Sticky wages, prices and
interest rates are a good thing; institutions which stabilize these are useful and should be
developed (national collective bargaining; incomes policy).
5.
IPK emphasizes insufficient aggregate demand as a cause for low growth as well
as recessions (NKE only recessions). IPK advocates demand enhancing policy, including
inequality reducing tax, transfer and expenditure systems, low interest rates, and
employer of last resort programs. Most IPK economists favor Lerner’s “functional
finance” theory of fiscal policy: the levels of taxation and government expenditure should
be consistent with full employment and price stability (Nell and Forstater 2003).
6.
Money is not neutral: changes in the price and availability of liquidity have
powerful effects on the real economy; macroeconomics should begin with an analysis of
the roles of liquidity in the economy, as in Keynes’s “monetary theory of production.”
But IPK economists are skeptical regarding the power of monetary policy by itself and
see fiscal policy as a more powerful tool for demand management. They are skeptical re
“rules,” in favor of “discretion” in policy.
7.
IPK follows Keynes and Kalecki in arguing that savings do not finance or
determine investment. Profit expectations, interest rates, the availability and the cost of
finance are the important influences on investment - not the flow of savings - since the
former variables are largely independent of saving. Savings are determined by the level
of income, itself determined by aggregate demand. The NK/NEG argument that policy
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should encourage higher saving is generally incorrect: high saving can mean low
aggregate demand, capacity utilization and investment.
8.
IPK puts a higher priority on full employment than on low inflation; full
employment is understood as the rate of unemployment that obtains when everyone who
desires employment and is willing to work at the going wage rate for workers with
comparable skills is employed. Inflation is seen as the result of distributional struggles
between capital and labor which can lead to “cost push” inflation. Again, institutions
which socially control wages, prices and the distribution of income are necessary for full
employment and price stability – some form of incomes policy. Many (but not all) IPK
economists argue for government employer of last resort programs as necessary for full
employment (Wray 1998).
9.
IPK sees a strong reinforcing link between demand, cycles and growth: high
demand leads to high employment and capacity utilization which leads to high
investment which leads to higher productivity in the next period (higher growth).
10.
The distribution of income influences aggregate demand. More equality is
demand, investment, profit and growth enhancing.
11.
IPK proposes “demand-led” growth economics; propositions 7, 8, 9 and 10 are
not in NKE/NEG; IPK is richer, has more explanatory power and more usefulness in
informing the design of macro policy. (See the essays in Cornwall and Cornwall 2001,
Setterfield 2002 and Nell 1992.)
12.
Most IPK economists favor some form of exchange rate regime which would
reduce exchange rate instability; most NKE economists accept flexible ER systems
(Davidson 2002).
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13.
IPK economists favor financial market regulation and see unregulated markets as
instability enhancing (Isenberg 2000); most NK economists see financial instability and
crises as occasional episodes which can be handled on an ad hoc basis.
What do economists actually believe about macroeconomics?
Most macroeconomic textbooks and surveys of modern macroeconomics such as
B. Snowden and J. Vane in their Modern Macroeconomics (2005, Chapter 12) argue that
there is an emerging consensus among macroeconomists based upon a New KeynesianNew Economic Growth Theory model. On the other hand, IPK economists argue against
the validity of this consensus (for example, Arestis and Sawyer 2004, Nell and Forstater
2003, Lavoie and Seccareccia 2005, and the contributors to the JPKE Symposium cited in
note1).
D. Fuller and D. Geide-Stevenson (2003) surveyed a random sample of 1000
AEA members; they report “fluidity” and not much consensus regarding
macroeconomics among the (298) respondents to their survey. The reported views on 18
macro propositions indicate as much support for propositions consistent with IPK as for
NKE or NCE propositions, suggesting that IPK views are fairly widely accepted and that
they might become more widely accepted in future.
Sources
Arestis, Phillip and Malcolm Sawyer. Neoliberal Economic Policy, Edward Elgar 2004.
Arestis, Phillip, M. Baddeley and J. McCombie (eds.). The New Monetary Policy,
Edward Elgar 2006.
Atkinson, Glen and Theodore Oleson. “Keynes and Commons: Their Attack on LaissezFaire,” Journal of Economic Issues 32: 1019-1030, 1998.
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Cornwall, John and Wendy Cornwall. Capitalist Development in the Twentieth Century:
An Evolutionary Keynesian Analysis. Cambride: Cambridge University Press. 2001.
Davidson, Paul. Financial Markets, Money, and the Real World, Northampton, Mass.;
Edward Elgar. 2002.
Davidson, Paul. “The Post Keynesian School,” in B. Snowden and H. Vane, Modern
Macroeconomics, Edward Elgar, 2005.
Federal Reserve Bank of Kansas City. Symposium: Rethinking Stabilization Policy,
2002.
Fuller, Dan and Doris Geide-Stevenson. “Consensus Among Economists Revisited,”
Journal of Economic Education (Fall): 369-87. 2003.
Hodgson, Geoff. “Post-Keynesianism and Institutionalism: Another Look at the Link.”
In Setterfield, 1999.
Isenberg, Dorene. “The Political Economy of Financial Reform.” In Robert Pollin (ed.),
Capitalism, Socialism and Radical Political Economy Northampton, MA: Edward Elgar.
2000.
Lavoie, Marc and Mario Seccareccia (eds.). Central Banking in the Modern World,
Edward Elgar, 2005.
Mankiw, N. Gregory. “A Quick Refresher Course in Macroeconomics,” Journal of
Economic Literature, 28 (December): 1645-1660, 1990.
Mankiw, N. Gregory and David Romer (eds). New Keynesian Economics. Cambridge,
MA: MIT Press. 1991.
Ann-Marie Meulendyke. U.S. Monetary Policy and Financial Markets. Federal Reserve
Bank of New York. 1998.
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Moore, Basil. “Economics and Complexity.” In Mark Setterfield (ed.) Growth,
Employment and Inflation. St. Martin’s and Macmillan, 1999.
Nell, Edward. Transformational Growth and Effective Demand. New York: New York
University Press. 1992.
Nell, Edward and Matthew Forstater (eds.). Reinventing Functional Finance:
Transformational Growth and Employment. Edward Elgar, 2003.
Niggle, Christopher. “A Short Course in Macroeconomics or Whatever Happened to
Monetarism?” Ms: University of Redlands (available at
www.redlands.edu/christopher_niggle/xml). 2004
Romer, Christina and David Romer. “The Evolution of Economic Understanding and
Postwar Stabilization Policy.” In Rethinking Stabilization Policy, FRB, KC 2002.
Romer, Paul. “The Origins of Endogenous Growth,” Journal of Economic Perspectives,
Winter, 1994.
Rotheim, Roy (ed.). New Keynesian Economics/Post Keynesian Alternatives. London
and New York:Routledge, 1998.
Setterfield, Mark (ed.). Growth, Employment and Inflation. St. Martin’s and Macmillan,
1999.
Setterfield, Mark (ed.). The Economics of Demand-Led Growth. Edward Elgar, 2002.
Snowdon, Brian and Howard Vane. “Conclusions and Reflections,” Chapter 12 of
Snowdon and Vane Modern Macroeconomics, Edward Elgar, 2005.
Tymoigne, Eric. “Keynes and Commons on Money.” Journal of Economic Issues 37
(3): 527-45, 2003.
Wray, L. Randall. Understanding Modern Money. Edward Elgar. 1998.
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1
For discussions of the emerging New Keynesian-New Economic Growth Theory consensus see
the Symposium on monetary policy in the Journal of Post Keynesian Economics, Summer 2002 (articles by
Arestis and Sawyer, Chick and Dow, Dalziel, Fontana, Fontana and Palacio-Vera, Mariscal and Howells);
Federal Reserve Bank of Kansas City, Symposium: Rethinking Stabilization Policy 2002 (especially C.
Romer and D. Romer,”The evolution of economic understanding and postwar stabilization policy); P.
Arestis and M. Sawyer 2004; Arestis, Baddeley and McCombie 2006; Lavoie and Seccareccia 2005; A.
Mulendyke 1998; Snowden and Vane 2005 (especially Ch. 12, “Conclusions and reflections”). John and
Wendy Cornwall 2001 propose the term “evolutionary Keynesianism” for their synthesis of institutionalism
and post Keynesian macroeconomics; it appears to be an appropriate term for the IPK approach.
2
For an extended version of this paper see Niggle 2004, which presents a brief narrative of the
history of macroeconomics since WWII as well as comparison and contrasts between the various schools of
thought during this period.
3
See Atkinson and Oleson 1998, Hodgson 1999, and Tymoigne 2003 for discussions of the
Institutionalist-PK connection.
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